In vogue: Seven financial fads that may become a financial faux pas

The catwalks of London are preparing to host the annual fashion week and just as with the financial world, there will be plenty of trends but also the odd faux pas.

The reception given to a dress, bag or pair of shoes can make or break a brand, but only until the next big theme emerges, and it can be the same in the world of investing

The fashion world has given us shell suits, leather trousers and socks with sandals, but so called innovation from the City of London has been just as intriguing.

Fashion: The catwalk, like the Square Mile, can set new trends

There has been a trend towards following the herd and selecting the flavour of the month, but this can be dangerous as not all investments are suitable for everyone.

Jason Hollands, managing director of broker Bestinvest, says: 'Investment fashions come and go and investors need to be wary, as sometimes the driving forces behind new product launches are the sales and marketing departments rather than the investment teams. Firms see new product launches as a quicker way to gather assets than the slower process of developing competitive track records on existing funds.

‘Once one firm comes up with a novel idea for a new fund, invariably there is a rush of 'me-too' products from competitors because the sales teams bleat that they are missing out on new business opportunities.'

Privatisation funds

Amid the privatisations of the mid-90s, asset managers launched funds to take advantage of growth from the formerly state-owned assets.

The idea was that investment in newly privatised assets would help those businesses grow globally, giving investors decent returns through a fund.

However, Mr Hollands explains: ‘These funds attracted much attention but within a few years they had morphed into general equity funds.’

Headache: Following the crowd isn't always the best investment strategy

The tech bubble

The growth of the internet in the early part of the 21st century saw the launch of technology, media and telecommunications companies offering to harness opportunities from the world wide web.

Excitement about the potential of the new technology attracted millions of pounds of investment and the creation of technology funds. However, in reality many technology companies were massively overvalued and their underlying fundamentals were weak.

Mr Hollands says: ‘Many of these companies soared to valuations that looked astronomical compared to their actual earnings but some talked of a ‘new paradigm’ where the old rules simply didn’t apply any more.

'Many retail investors were lured into fundamentally speculative funds by stellar returns they were delivering, throwing all caution to the wind.

While this was a very uncomfortable period for those fund managers who placed a strong emphasis on identifying cheap, undervalued companies, fundamentals have a habit of reasserting themselves, and the bubble ultimately burst with investors racking up huge losses.’

Climate change funds

Melting ice caps, Al Gore and frequently wet summers in the UK have all pushed the climate change debate up the agenda.

While a subject like climate change would usually come under the remit of ethical investment as investors look to avoid wasteful and polluting companies, some fund managers have launched products that play on talk that we will have to adopt a low carbon economy.

Mr Hollands explains: 'Only a few years ago, it was impossible to get through a television broadcast or newspaper without viewing a story that referred to the impact of global warming or climate change.

As if on cue, from around 2007, asset managers began launching funds to take advantage of climate change as a theme, investing in companies that might benefit from mitigating the impact of the changing climate or adaptation to it.

‘These were not narrow alternative energy funds but ones which invested in stocks that might benefit from the shift towards low-carbon economy. Generally these funds have gone on to disappoint and investor interest demand has waned.’

Enhanced alpha funds

Fund managers got over confident as economies overheated in the pre-credit crunch world before 2008.

Many launched funds that allowed them to be totally exposed to the market by taking both a long and short term view of the stocks. The idea of these ‘enhanced alpha’ funds was that they could use the cash from shorting stocks to bolster the long term aspect of the portfolio.

Mr Hollands says: 'The credit crisis unfurled shortly after these funds were launched, and the last thing investors needed was experimental, super-charged funds in a market where liquidity dried up and counter-party risk was high on the radar. The result was that many of the 130/30 funds quietly wound up or at least ceased being actively marketed. The idea was interesting but in hindsight the timing was wrong.'

Own goal: Shell suits, as worn here by former footballer John Aldridge, were a key feature of the late 20th Century, but like some financial products, are now ridiculed

Multi-manager funds

If you don’t have the time or resources to find a top performing fund manager, why not ask an expert to do it for you.

That is the idea of a multi-manager fund. An investment firm will put together a portfolio of top funds, or fund managers, from across the industry with the aim of harnessing their knowledge for a decent return. It works a bit like creating a fantasy football team, but a lot more expensive.

Mr Hollands says: 'Multi-manager funds have significantly grown their share of the market in recent years, with many advisers using them as their core ‘solution’ for clients. And while there are merits to this approach in terms of diversification and professional management, the costs are higher and there may be some long-term pitfalls as some multi-managers achieve such large scale this is impacting their ability to invest in smaller funds which may hold the potential for better returns.’

Passive investing

Unfashionable: Socks and sandals are seen as a fashion faux pas

The abolition of commission and introduction of rules surrounding transparency has put active management under the spotlight.

Investors have rightly questioned the returns they are getting from active managers for the amount they are paying in fees.

This has created an opportunity for passive products, such as exchange traded funds and trackers, to flex their muscle, and boast about lower charges and more value for money.

Mr Hollands says: ‘Some investors have got out of the business of fund research altogether and are adopting an approach of solely investing in passive investments, such as index tackers or exchange traded funds.

'The latter types of investments have seen explosive growth over the last decade. While passive investments can play an important part in a portfolio and make sense in strongly rising markets where an investor needs to efficiently capture the general upward trend at low cost, they are not a panacea and won’t suit every eventuality, especially if markets enter a bumpier phase.

‘In recent years markets have been heavily driven by policy decisions and the actions of central banks and relatively less so by company fundamentals which has favoured passives over actively managed investments. A return to more normal markets could reveal the flaws of an approach exclusively anchored to passive-investing.’

Absolute return funds

New European regulations in 2009 allowed fund managers to invest in a great range of securities.

This opened up the derivatives market and gave fund managers the impetus to construct absolute return funds.

The idea was that fund managers could now use hedge fund tools such as derivatives to always guarantee some sort of return for investors.

Mr Hollands said: 'Many of these funds have quite simply failed to deliver and scepticism is widespread towards the often generous performance fee structures some of these funds put in place.

‘High correlation between different asset classes, driven by the distorting impact of quantitative easing has now helped these funds and the next few years are going to provide a chance for some of these managers to redeem themselves.’

FUND JARGON BUSTER

The investment industry's world of abbreviations...Acc: Accumulation - any income generated by the fund like dividends or interest is automatically reinvested.Inc: Income - any income generated is distributed by the fund instead of being reinvested. Dis: Distribution - any income generated is distributed by the fund instead of being reinvested. R: Retail - the fund is aimed at ordinary investors. I/Inst: Institutional - the fund is aimed at corporate investors like pension funds. A, B, M, X etc: Different fund houses use letters for different things. Check with them what they stand for. NT/No trail: Some fund houses use this name on clean funds which carry no commissions for financial advisers, supermarkets or brokers, just the fee levied by the fund manager. But other fund houses use different letters - I, D or Y, for example - so you need to find out for yourself which are clean funds. Gr: Stands for gross. GBP/£: Fund denominated in pounds. EUR: Fund denominated in euros. USD/$: Fund denominated in US dollars. Compiled with online stockbroker The Share Centre